Is Grafenia (LON:GRA) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Grafenia Plc (LON:GRA) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Grafenia

What Is Grafenia's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Grafenia had UK£3.18m of debt, an increase on UK£81.0k, over one year. However, its balance sheet shows it holds UK£3.68m in cash, so it actually has UK£504.0k net cash.

How Strong Is Grafenia's Balance Sheet?

The latest balance sheet data shows that Grafenia had liabilities of UK£3.60m due within a year, and liabilities of UK£6.84m falling due after that. Offsetting this, it had UK£3.68m in cash and UK£2.24m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£4.52m.

Grafenia has a market capitalization of UK£7.73m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Grafenia boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Grafenia will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Grafenia had a loss before interest and tax, and actually shrunk its revenue by 23%, to UK£12m. That makes us nervous, to say the least.

So How Risky Is Grafenia?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Grafenia had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through UK£942k of cash and made a loss of UK£3.5m. With only UK£504.0k on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Grafenia you should be aware of, and 1 of them makes us a bit uncomfortable.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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